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Sunday, November 9, 2014

Royal Jordanian: Why the Government should get out of the the aviation industry

Jordan’s flag
carrier, Royal Jordanian, offers great service. RJ is part of the prestigious
One World alliance and avails a good choice of onboard entertainment. Its
economy seats are spacious and business seats luxurious. In 2013, the airline’s
32 planes carried 3.3 million passengers: More than half of total passengers passing
through Amman’s Queen Alia International Airport. It also generated 760 million
JDs in revenues in 2013. All that remains for the airline is to find profits,
any profits!

Royal
Jordanian’s balance sheet is dismal. The company recorded a loss of 39 million
JDs in 2013, following a small profit of 1.1 million JDs in 2012 and a massive
loss of 58 million JDs in 2011. Its cumulative losses are over three quarters
of its capital and its book value is barely 10% of paid capital. Essentially,
the losses have wiped out most of shareholders’ equity. The company has to
raise capital by 50 million JDs before March 2015 in order to stave off
liquidation and violation of loan terms it struck with its lenders.

RJ
management has set out plans to reverse the airline’s fortunes. In addition to
the 50 million JDs capital raise before March 2015, management plans to raise
RJ’s capital by an extra 100 million JDs by 2018. If successful, this will
increase its capital to 234 million JDs. A capital raise would solve the
current major problem of negative working capital and also allow the airline to
pay down some of its debt which exceeded 105 million JDs by end of 2013.

Management’s
turnaround plans also include reducing the number of planes operated by the
company to 29 by end of 2014, down from 32 in 2013. The airline will replace
the old leased Airbus 340 and 330 by the new _also leased_ Boeing 787s whose
fuel costs are 20% lower_ albeit at higher lease costs. Management also plans
to offer voluntary layoffs for some of its employees whose numbers totaled 4643
people in 2013. The airline also plans to reduce the number of destinations
served and drop some loss making routes.

Lower fuel
costs would help as well. Royal Jordanian paid 284 million JODs for fuel in
2013, amounting to 37% of its revenues. In 2010, the last year the airline made
a respectable profit of 9.6 million JDs, fuel cost stood at only 30% of
revenues. Fuel cost as a % of revenues was 40% in 2011 and 36% in 2012. The
government decision to allow RJ to buy fuel in the local market competitively,
should save it some 12 million JDs every year. If Brent remains below 100 US$ a
barrel for 2014 and 2015, the fuel yoke on RJ would become lighter.

All is not
lost for Royal Jordanian. Other airlines in the region were able to do
successful restructuring the brought them profitability and growth. Lebanon’s
Middle East Airlines in Lebanon is one example. The recipe includes rationalized
fleet, good service, restructuring routes and dropping chronically loss making
ones and reducing total headcount.

But should Jordan’s
government remain in the airline? Restructuring the airline and raising its
capital maybe a good point for the Government to exit from Royal Jordanian all
together. Jordan’s government had raised 185 million JDs when it sold 74% of
the company in 2007. It was able to privatize RJ after waiving some 1 billion
US$ in debts that RJ owed in fuel debt, effectively cumulative losses borne by
the treasury. The presence of the government as the largest owner has also prevented
a more streamlined operations and management of the company. The government’s
best course is to exit the airline fully and allow RJ to be fully privatized
through the capital increase required. This would certainly be better than
increasing Jordan’s public debt to finance the Government paying for its share
of capital increase.

For RJ to
attract fresh capital from current and new shareholders, it must show a solid
turn-around plan. This plan must certainly include regulatory certainty and
visibility on issues related to taxes, route rights and the ability to
restructure RJ’s labor. This is where Government action is most needed: It must
provide such regulatory visibility and certainty, as it leaves the airline to
chart out its own independent future.